The Innovation - through - Acquisition Strategy: Why the Pay-off Isn't Always There
Published: November 16, 2005 in Knowledge@Wharton

Very informative article......

That was the mantra of leading technology companies in the tech boom days of the 1990s, when innovation was moving at such a frantic forward pace that even industry leaders like Cisco couldn’t keep up with the latest advances. Faced with the prospect of falling behind the competition, top companies began buying up smaller firms -- and their promising, if untested, technologies -- to stay on the cutting edge.

For a while, the strategy seemed to be a good one, or at the very least, a popular one. Companies spent $3.5 trillion on acquisitions between 1992 and 2000, making those eight years the most active M&A period in history. Then the tech bubble burst and M&A activity came to a screeching halt. Acquisition leader Cisco, which purchased 70 companies between 1992 and 2000, bought just two in 2001. It became evident that while some purchases helped acquirers reap benefits, many failed to create the intended value. Wharton management professor Saikat Chaudhuri believes he knows why. His research is especially timely given the recent growth in M&A activity in the tech sector and other innovation-driven industries……..

Four Major Challenges

By examining the challenges of the innovation-through-acquisition strategy in detail, Chaudhuri’s work offers suggestions to managers on what kinds of target companies are worth pursuing and what strategies should be used to integrate those companies once they have been bought.

Innovation acquisitions, according to Chaudhuri, present four major challenges at the product, organization, and market levels: integrative complexity due to technological incompatibilities, integrative complexity due to the “maturity” of a target company, the unpredictability of a product’s performance trajectory (“technical uncertainty”) and the unpredictability of that product’s market (“market uncertainty”). Different target companies present different degrees of these variables, he says, and so each acquisition presents its own benefits and drawbacks.

For instance, by buying a company whose products are based on a different technological platform, a purchasing company can gain new technological functionalities and capabilities. But such a deal would also pose a significant integration challenge because the platform disparity would have to be resolved. Chaudhuri points to Microsoft’s purchase of Hotmail as an example. At the time of the deal, Microsoft was based on Windows, Hotmail on UNIX. “It took a few years to integrate those functionalities seamlessly,” he says.

Similarly, acquiring an older, more mature firm can offer stocks of proven competencies as well as optimized processes, but poses greater integration challenges due to entrenched work routines and cultures and more cumbersome task reallocations…….

While “complexity” challenges in innovation acquisitions are real, visible and significant, it is the “uncertainty” variables -- the unpredictability of markets and product success -- that present the larger challenge for purchasing firms. According to Chaudhuri’s research, technical incompatibilities between two merging companies slowed the time it takes to get a product on the market, but did not hurt financial performance; target maturity was positively correlated with performance. Technical and market uncertainty, however, were shown to both slow the time to market and result in diminished financial returns.

In one of two papers that resulted from his research project -- ”The Multilevel Impact of Complexity and Uncertainty on the Performance of Innovation-Motivated Acquisitions” -- Chaudhuri says that while “companies have been able to recognize, and have learned how to manage and even exploit, integrative complexity,” they have been unable “to cope with product and environmental uncertainty in these innovation acquisitions.... The findings suggest that companies tend to give attention to those innovation acquisitions which are complex, but underestimate, or are unsure how to handle, those deals surrounded by uncertainty. Existing acquisition processes appear to be geared towards managing complexity rather than uncertainty.”

When a company buys a target with unfinished products, it brings the possibility of securing promising technologies and the ability to influence their progress, he says. “But there’s also the risk that the technologies just won’t develop as expected, and less knowledge about the technology means that less focused planning can be done upfront in resource allocation and integration.”…..

Flawed Strategy

Among his more important findings is Chaudhuri’s contention that “buying companies with early-stage products and entering uncertain markets had substantially adverse effects.” That’s significant, because it flies in the face of the notion that buying these “uncertain” products and companies is a good strategy simply because it might pay off down the road…….

That’s because “complexity is intrinsically predictable,” Chaudhuri notes. “If one places sufficient resources and project management strategies in the right places, it’s possible to manage the complexity. You can learn how to do it. But uncertainty, by its very nature, requires constant adjustment. This type of flexibility is tough to achieve, especially in the middle of integration activity.”